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Friday, August 19, 2011

Day 307 - Why You Should Avoid Country Funds (Guest Post)

Guest post via Jon at Free Money Wisdom. It's great to introduce some investing perspective into The $60K Project mix.

Many investors are familiar with country funds, even if the term isn't one that is used very frequently. Country funds, simply put, are those portfolios which consist of stocks and other securities from a foreign country. For example, in the United States a country fund might consist of stocks exclusively from China. While these funds are certainly capable of fast growth, the risk certainly outweighs the reward.

Typically, the smartest portfolios are those which are diversified. Educated investors know that even if an industry is booming, it isn't smart to invest all in that one industry. The market rewards risk, but it also punishes risk - especially if there is too much risk. It's easy to look at the recent statistics for a country's financial markets and think that investing there is the path to financial success. Keep in mind, though, that the markets are unknowable. A gain today doesn't necessarily promise a gain tomorrow. Stability is a major factor to look at. Developing nations are especially susceptible to a rapid boom and bust cycle.

Don’t take things for granted

To understand this, it's critical to not think of every other country in the same sense that you do about American and European investments. The markets in America are very developed and also very stable. While there has been turmoil in American markets recently, they still will not crash and disappear overnight. This is something that's easy to take for granted when investing in American securities, because most investors have never had to consider it. It's just a trait of our markets and one of the benefits from having such a well-regulated financial market. The same cannot be said for other countries.

Government influence

One reason that the markets in other countries aren't as stable is their governments. A nation currently experiencing a boom cycle that looks attractive on paper might be experiencing the benefits of a new government. It's easy for companies to make huge percentage gains in underdeveloped nations where the economies are still fledgling. However, the same turmoil that makes these massive gains possible also means an equal if not greater chance of massive losses.

Corruption

Corruption is another reason to stay away from country funds. As previously mentioned, the American stock market has a strong amount of regulation. There is built-in incentive for company executives to act in an honest manner. This prevents instances similar to Enron from occurring, and generally helps to keep the stock market both honest and stable. In other countries, however, this may not be the case. Poor regulations in countries with developing financial markets means more corruption, and more chance for the bottom to fall out from under that nation's economy. This is especially true in countries such as China where governments control news outlets. In these instances, information may be obscured. And that brings us to the final reason to steer clear of country funds.

Uninformed!

An inability to remain current and informed on the happenings in a country's financial sector is also a reason to avoid country funds. This is another one of those aspects of the American financial markets that we tend to take for granted. At any time, a person can get online and obtain live news and quotes regarding the stock market in America. This becomes considerably difficult for nations with less developed infrastructures. Wise investors keep up on the news for the sectors they've invested in, and can adjust their portfolios accordingly. This just isn't possible with some country funds.

Stay far, far away

In the end, avoiding country funds comes down to a matter of common sense. It's a show of poor financial acumen to put all of your eggs in one basket. Even for the most risk-seeking of investors, country funds are a poor option. With all of the options that investors have domestically, there's no need to add in the unnecessary risk provided by a country fund. Investors should avoid the potential nightmares of country funds and instead hang on to their diversified, domestic portfolios.